Wednesday, December 23, 2015

Facebook Debate Requires One More Attempt at Reasoning With Doubters

Here is another shot at what
is becoming a tedious subject for me and probably for some of you who may read
this blog.

Virtually all of my friends
and correspondents cling to the ideological certainty that the federal
government spends too much and will soon go broke because of it. They cannot
conceive of the idea that the federal government does not need tax money in
order to spend. They also are convinced that the government must borrow money
in order to spend, thus digging itself into deeper and deeper debt that we, the
taxpayers, must eventually cough up the dough to repay.

Why, I ask you, would a nation
that has full Constitutional authority and financial wherewithal to "print"
(that is, to create and issue) money need to tax and borrow other peoples' US
dollars in order to get money to spend? Is it absurd to think that the US
government creates money? No, even my doubting Thomas friends and
correspondents readily admit that the government can and does "print"
money. Still, they cling to the paradigm of the US government having the same
financial constraints as a business or household. Why is that?

Okay, there are constraints,
two of them, but both are self-imposed by Congressional dictate as a means of,
I guess, controlling inflation. I will get to those two constraints in a minute,
but first let me tell you how the federal government creates US dollars (and it
does not "print" them and scatter them to the wind for people to
latch onto).

First, the federal government
issues a check or an electronic deposit and voila, someone's bank account
balance is increased. Simultaneously, the central bank (the Fed) marks up the receiving
bank's reserve balance. The reserve balance is the number of on-account dollars
the receiving bank has with the Fed to clear checks. The Fed creates those reserve
balance dollars out of thin air when the government spends. That is how banks
get the money to cash and clear checks. They do not use depositor dollars for
those purposes. By authorizing the Fed to create reserves, the federal
government creates money when it spends.

Now let us look at the two self-imposed
and arbitrary artificial constraints on the monetary system. The first is that
when the government runs a spending deficit, the Treasury must "borrow"
money in an amount equal to that deficit by selling bonds, notes, and other
security types to the public. The federal deficit is the amount the government
spends in excess of tax collections in a given year. For example, if the
government spends $4 trillion in a year and collects $3 trillion in taxes, the
deficit equals $1 trillion and the Treasury must sell $1 trillion in
securities. On the surface, it would seem that the government "borrows"
the money from the sale of securities in order to pay for what it spent in
excess of its tax "revenue". This is not really the case because the
government had already created the money and paid for what it spent. The
Treasury, therefore, does not spend the money it receives from the sale of
securities. The securities money really goes into the buyers' (investors) accounts
at the Fed as safe and secure investment savings. The Fed returns those savings
to the buyers (investors) along with some newly created interest dollars when
the securities expire. The purpose of selling Treasury securities is to take
dollars out of circulation thus offsetting any inflationary pressure federal
spending might have triggered, not to acquire money to spend.

The government defines the federal
"debt", currently approaching $19 trillion, as the total dollar amount
of outstanding Treasury securities at any one time. This leads us to the second
self-imposed and arbitrary artificial constraint on the monetary system - the
debt ceiling. Even though Congress requires the Treasury to sell securities
equal to the deficit as described above, it also imposes a limit on the total
amount of Treasury security dollars in existence at a given time. Thus, if Congress
sets the debt ceiling at $20 trillion and the deficit becomes $1.5 trillion,
the Treasury must sell securities equal to $1.5 trillion. Selling that amount
of securities, however, would cause the outstanding treasury security balance
to exceed the $20 trillion debt ceiling. Congress would have has painted itself
into a corner (and frequently does) with its two conflicting rules. Congress creates
a deficit by spending more than it gets in taxes, but does not tie its spending
to the debt ceiling until after it has already spent. That is why Congress must
periodically raise its arbitrary debt ceiling. The fact that Congress has spent
the money before selling the securities is ample proof that the government does
not depend on borrowing in order to spend.

These two arbitrary
constraints on the federal monetary system have caused untold waste and rancor
in Congressional debate. They have also bamboozled the American public into
believing that the US government must borrow money in order to spend, even from
competitor nations such as China, which itself invests its extra US dollars
from its trade surplus into Treasury securities for safe-keeping and to earn
interest. Neither constraint is necessary now that the US monetary system is no
longer on a gold standard and no longer runs the risk of insolvency. The whole
premise that the federal government accrues "debt" from spending and
borrowing is pure fabrication.

The US dollar is itself a debt
- that is - it is an IOU of the federal government to pay the holder of that
dollar another US dollar, nothing else. It is simply a permanent or temporary
accounting liability. The other side of that liability, the asset, belongs to
the holder of that US dollar. Those asset holders are we in the private sector.

Do not federal taxes pay for
federal spending, you might argue. No. The receipt of federal tax dollars by
the Treasury removes those assets from the holder and removes the liabilities from
the government. Tax dollars simply go out of existence, even though ledger
entries continue to show their amounts.

In summary, the federal
government creates US dollars by spending. It destroys US dollars by taxing. It
neutralizes US dollars by parking them in Treasury securities. The government
does not tax or borrow in order to spend but I will bet that you, the reader,
and most of Congress do not believe it.

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About Me

Jim Gaddis is a retired computer professional with an avid interest in local history, sports, certain kinds of music, and economics. Researching the life and career of R. C. Gatlin has been an enjoyable project of his for several years.